an economics scrapbook

The face of the river, in time, became a wonderful book . . . which told its mind to me without reserve, delivering its most cherished secrets as clearly as if it had uttered them with a voice.
-- Mark Twain

Happy New Year! It has been far too long since I’ve posted – apologies to all. The Paper Boat set out for a leisurely float about the harbor one sunny day in August, when it just disappeared. Some folks say something dark lay beneath the ocean’s glassy surface that day, and the boat was pulled down. Some say it wandered too far from charted waters and was lost at sea, surfing the edge of the world before succumbing to the insidious grip of the mighty Kraken. But news has just come in that our sturdy vessel has survived! It has been spotted skipping waves amongst the trusted pages of Forbes Magazine!

Origami from single sheet of paper, Peabody Essex Museum, MA.

In his recent article at Forbes, Big Banks and Derivatives: Why Another Financial Crisis Is Inevitable, Steve Denning cites research from earlier post The Derivatives Time Bomb here at The Paper Boat. He agrees that the derivatives market is precarious, and goes so far as to declare global financial meltdown is on the way. He reveals that many of the banks considered the safest today are actually at great risk due to derivatives transactions hiding beneath benign sounding labels. Wells Fargo, for example, shows activity it calls “customer accommodations” on its books with a notional risk totaling two trillion dollars. This vast allocation of funds is actually invested in derivatives arguably no safer than bets placed at a casino. Other banks are in far deeper. JP Morgan showed a notional amount of $72 trillion on its books at the end of the third quarter of 2012. As Denning points out, “that’s five times the size of the US economy, or about the same size as the world economy.”

Another shocking revelation Denning provides is a look into the use of off-balance-sheet accounting devices, such as “variable interest entities” (VIEs), at veritably every major bank. These are basically no different from the “special-purpose entities” used by Enron to hide its debt. What’s worse is banks exclude some of these VIEs from consideration altogether, in the same way and for the same reasons that Enron excluded its special-purpose entities, claiming their involvement is insignificant or temporary, or that they do not operate the deals. The opacity under which bank funds are managed on the micro level seems to be just as dense as that under which the derivatives market operates on the macro. Considering the unfathomable monetary numbers involved across the board, this is not good news. It seems the global system may indeed be at risk of collapse.